Indonesia had cause to celebrate as it ushered in 2012. Fitch and Moody’s both lifted Indonesia’s sovereign credit rating out of junk status, where it had languished since the 1997 regional financial collapse. “A decade ago, after the Asian currency crisis, nobody really viewed Indonesia as an investment destination,” says Jeff Smith, a partner and head of south-east Asia at Norton Rose in Singapore. “But now Indonesia is politically and economically stable, with 250 million people and vast natural resources – many expect Indonesia will become one of the largest economies in the world over the next few decades.”

Indonesia plans to grow its economy by almost 7% per year, and if successful would join the Brazil, Russia, India and China (BRIC) nations as a world economic force. But this will not happen without a radical improvement in its infrastructure. Indonesia requires around $350 billion of energy and transport investment over the next five years, according to Oxford Business Group. Indeed, the Indonesia National Development Planning Board already has more than 90 projects, worth almost $80 billion, on the drawing board.

The dealflow in the first part of 2012 has been healthy. There was the $500 million bond for the refinancing and expansion of the Cikarang plant, Krakatau Posco’s $1.7 billion 14-year facility to fund a 1.5 million tonnes-per-year integrated steel mill, and China Huadian’s $330.6 million refinancing for the Asahan 1 hydroelectric plant. The deals involve a diverse set of funding sources, including high-yield dollar debt, regional and local commercial banks, international banks, Islamic finance and export credit agencies.

The deals, however, mask some of the wider issues with Indonesia’s development plan. “There are still a number of challenges facing Indonesian projects,” Norton Rose’s Smith says. “For example, there is not the sort of standardised documentation that can be found in the place like the UK, which can make the development of projects inconsistent and make investors wary over participating. The political system is also not as transparent as it could be and there are always doubts as to whether companies will get a fair hearing in courts or obtain the necessary permits.”

One case in point is a recent decree issued by the government that would cut foreign mining companies’ ownership of local projects. The government wants to reduce their maximum holding from 80% to 49% within the next decade. Investors worry that the change could result in a rushed, wholesale divestment.

The IIGF takes lead among guarantees

Indonesia has attempted to improve the framework for new projects. In August 2011, the Minister of Finance issued a decree that allows for the issuance of a business viability guarantee letter for selected independent power projects. The initiative effectively covers the risk of non-payment for power purchased by the state energy company, PLN, and should allow for the acceleration of IPP development timetables.

Geothermal projects will benefit from a similar guarantee framework, which was unveiled the same month. The framework for geothermal will feature identical cover of PLN’s obligations, but also includes guarantees covering projects’ exploration and construction stages. Indonesia is estimated to have 40% of the world’s geothermal reserves.

PLN still dominates power procurement, and with some high- profile exceptions, has placed an emphasis on private sector involvement in construction rather than financing and operations. In February, for instance, PLN awarded contracts for 600MW South Sumatra 6 and 1,240 MW South Sumatra 8 to Posco/DH and Bukit Asam/China Huadian, respectively.

The more high-profile initiative, however, is the Indonesia Infrastructure Guarantee Fund (IIGF), established in late 2009 under Presidential Regulation No. 13/2010, as a response to the need for “adequate assurance against the political risks inherent in infrastructure investments”.

The IIGF is designed to protect the private sector against financial losses on infrastructure projects that might result from government actions or inactions, including delays during the permit and license application process, any changes to rules and regulations, the lack of tariff adjustments, and failure to integrate a project into a network or ancillary facilities. The facility is designed in part to allow projects to raise longer-tenor debt.

In late 2011 the IIGF confirmed its participation in the landmark $4 billion, 2,000MW Central Java coal-fired independent power project. The plant’s sponsors are Itochu, J-Power and Adaro, which have signed a 25-year power purchase agreement with PLN. In November the IIGF signed on to support the provincial government of Kalimantan’s procurement of the Central Kalimantan Railway, a line running between Bangkuang Puruk Cahu, Batanjung and Lupak, with a range of between 185km and 400km. While the Central Kalimantan Railway is still in the preparation stages, the move is a sign that IIGF is taking an active role in the early phases of Indonesian projects.

IIGF involvement carries a fee, consisting of one-time payment based on the project value and a recurring fee, based on maximum exposure uncer the guarantee, which depends on the project risk profile, guarantee coverage and guarantee period. The IIGF says the recurring fee is around 50bp to 100bp, which is still competitive with comparable commercial pricing. “Government support has been very significant, with organisations such as the IIGF playing a critical role in supporting and structuring projects,” explains James Harris, managing partner of Hogan Lovells Lee & Lee’s in Singapore. “Such guarantee facilities were what the market was missing.”

These guarantees, say market participants, are welcome, but are not sufficient because projects still require additional support. As such, the real reforms need to occur at the legislative level. “[The main challenges is] finding feasible projects,” says one banker active in Asia. “The ability to secure land and water rights has been a major challenge, although a new land law was passed in December 2011, which should help resolve some of these problems. Government support arrangements are still only at an early stage of development, being limited to guarantees, with no viability gap funding available, although the Ministry of Finance is working on it.”

“The recent changes in the law, including allowing sub-sovereign entities to utilise private financing and PPPs for public projects, have been crucial,” adds Harris. “It has meant deals such as Central Java IPP and the Bandar Lampung water treatment plant can progress because there is a clearer framework now in place.”

Does Indonesia have time to firm up deal structures?

Central Java and Bandar Lampung are the type of deals that Indonesia needs to close if the country can deliver on its promises. Bandar Lampung is a $100 million water treatment plant located in the city of the same name that will produce 41 million litres per day of drinking water. Municipal utility Perusahaan Daerah Air Minum Way Rilau released the request for qualifications for the project in January. The PPP concession has already lined up government funding, IIGF backing and a World Bank partial risk guarantee.

“Although Indonesian PPP has made significant and positive progress in recent years, it remains very much in the early stages in terms of deal implementation,” Harris says. “There are a number of important projects that need to happen before the real breakthrough can occur. Those projects will create the template for future deals. Bringing bankable projects to fruition in emerging PPP markets can be a protracted process because of the various contracts, risk assessments and deal structuring. This may make the process slow but, in the long term, it is a better option than rushing projects to market,” Harris says. “The vital point is that the deals are a success for both the public and private sides.”

What is certain is that Indonesia is going to need a lot of external investment to fund the programme. Indonesia’s domestic banking market is relatively robust, with four state-controlled banks – including Bank Negara Indonesia and Bank Mandiri – working alongside over 100 local banks. But the resources of these local banks are limited, and so large project financings often require involvement from an international or export bank.

One Asian banker says such institutions will probably be very important in providing long-term financings for Indonesian assets. “Local banks are very liquid, but they are mainly providing short-term debt,” he adds. “In some cases, local banks are starting to provide longer tenors but they lack experience in cashflow-based lending.”

“There is certainly enough interest in Indonesian projects from the banks, especially the commercial and export banks, which shows the potential for deals to happen,” Harris says. “The domestic banks are also looking to step up but currently do not have the history of providing the levels of debt for the tenors required.”

Krakatau Posco, for instance, brought in ANZ, BTMU, Credit Suisse, HSBC, Mizuho Corporate Bank, Standard Chartered and SMBC, as well as the International Finance Corporation, the Asian Development Bank and JBIC, which have all been active on Indonesian deals. The World Bank and the ADB are sponsors of the IIGF. JBIC, meanwhile, has pledged $1 billion for the Central Java project and a geothermal power plant in Sarula, and this year provided a $100 million export credit line to Indonesia Eximbank.

Indonesian banks do not have substantial access to US dollar funding, which requires commercial and export banks to step up to help fund the gap. “The local finance market has limited capacity for long-term US dollar financing, so international banks and multilateral agencies will play a major role in future financings, and many of those of financings will be co-ordinated out of Singapore and Hong Kong,” explains Smith.

Yields of gold

Indonesia’s resources producers have long had access to uncovered dollar debt, whether as leveraged loans or bonds. Bond issues have been on the rise, with the most high-profile recent issue being the recent $500 million seven-year high-yield bond from Cikarang Listrindo.

Barclays Capital and Credit Suisse led the issue, which was the country’s first since it reached investment grade. The bonds had a yield of 6.95%, well within initial guidance of 7.5%, and generated $4.3 billion in orders. The strong interest has led to a prediction that more high-yield offers could follow because of the high demand for decent returns.

The Cikarang bond was more of a corporate credit. The issuer’s main asset is a 646MW combined-cycle gas-fired power plant that is already operational, and the bulk of the revenue went to refinance existing debt, although Cikarang plans to construct an additional 280MW coal-fired unit. As such, there is still some scepticism as to whether such high-yield solutions would be viable for pure project financings. “Transactional project finance bonds are a possibility in Indonesia, but still a way off,” Mr Harris says. “Once the pathfinder deals have closed they may be easier to bring to market but it will take some time.”

According to PPP Indonesia, a consulting firm, there are four projects at the feasibility study stage that could be funded using municipal finance methods. They are: the South Jakarta hospital; Gebang terminal; Casablanka waste water network; and Daan Mogot Flats construction. A further 16 have also been identified for potential municipal bond financings.

Wahyu Utomo, the head of the Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development, has indicated that the government will launch 84 infrastructure projects worth almost $60 billion over the next year, although details were sketchy, and about 38 of them are designed to be financed by the private sector.

If the reforms allow a new wave of projects to come to market, the future looks bright. “The evolution of the market in Indonesia really depends on the availability of projects,” the banker concludes. “If the new land law is effective, and government is willing to provide support we should start to see projects in the road, sea and possibly airport sectors emerging.” It may be a slow journey, but Indonesia appears to be on the right path.